Procurement as a Strategic Function

Procurement as a Strategic Function

 

Purchasing is one of the basic processes common to all organizations; it is the process of acquiring goods, services, and equipment from another organization in a legal and ethical manner.  Purchasing has evolved into more of a strategic function, shifting from getting the best price to getting the lowest total cost of ownership.  While purchasing provided the basis for acquiring goods and service for and organization, terms such as supply management, procurement and strategic sourcing are more synonymous with the strategic nature of purchasing today.  Supply Management (also known as procurement), is a five stage process which denotes and more comprehensive view:

  • Translating need into a statement describing the item or service required to satisfy the need.  85% of the cost of an item or service is determined during this stage.
  • Indentifying suppliers who will satisfy the need.
  • Establishing and fair and reasonable price for the item or service purchased.
  • Establishing an enforceable agreement for the purchase which meets the needs of both parties
  • Managing the relationship to ensure timely delivery of the item or service.

 

In the strategic cost phase, we gained a great deal of experience in determining the cost and price of a product.  In the procurement and contracts phase, we will look at the other three processes in more detail. 

 

Strategic sourcing represents increasing responsibility for supply management.  Strategic sourcing formalizes three activities:

  • Periodic analysis of an organization’s spending
  • Analysis of the supply market for the item
  • Development of a sourcing strategy which supports corporate strategy while minimizing costs and risks

 

As one can see, procurement is a comprehensive process which is critical for any firm to manage.

 

 

 

The Five M’s

 

The basic goal of any organization is to develop and produce products or services which can be marketed and sold at a profit.  Organizations accomplish this goal through what is called the five M’s:

  • Machines
  • Manpower
  • Materials
  • Money
  • Management

 

Organizations are constantly challenged with materials.  There has been much off shoring today, where forms attempt to procure materials at the right time, in the right quantity, at the right cost, and get them to the right place.  Failure to meet these criteria for materials adds to supply chain cost and decreases a firm’s profits.

 

Manpower (labor) also represents and significant cost.  Early in the industrial revolution, labor was not as significant to the overall cost of an item.  There was a lot of cheaper labor, so productivity was not as big of an issue.  The changing of marketing influence where retailers dominate the market has driven where consumers now demand lower prices for an item, and hence, productivity is now more important than ever.  Management began to shift its emphasis from using labor to using machines and technology for productivity gains.  The introduction of machines, coupled with more progressive management to develop and utilize more machines made the emergence of the factory system possible.  The emergence of machines led to more specialized skills for labor to operate the machines, which caused labor as a percentage cost of product to decline relative to material cost.  Controlling the costs of labor, materials, and machines (overhead) allows for better optimal use of cash (money) within a firm.  We learned how supply chain management makes an impact on cash for the firm during the strategic phases of the course.

 

Supply Management and the Bottom Line

 

In the strategic phase of the course, we learned how to map supply chain activities to the balance sheet, income statement, and the cash flow statement order to reduce overall supply chain costs.  Mapping procurement costs is no different.  Procurement affects most assets line items on the balance sheet, as well as cost of goods sold and expenses on the income statement.  More dollars are spent for procuring materials and services than all other costs combined, so it is very important to know how procurement costs impact the firm’s profitability.  Good procurement best practices can add value to a firm by increasing revenues and decreasing costs, which can increase profitability and return on assets, which ultimately leads to increased return on equity and greater shareholder value.  Here are some of the benefits of executing on procurement best practices:

 

  • Increased Sales
    • Faster market or time-based competition – Being first to market most times gives a firm a competitive advantage in holding the majority of market share.  Time based competition also includes a firm’s ability to meet unexpected surges in demand.  The development and management of a competent, responsive supply base plays a critical role in a firm’s ability to meet unexpected demand.

 

    • Improved quality – Quality is extremely important in meeting customer expectations.  If expectations of the customer are not met, this can result in lost sales.  Seventy-five percent of quality problems can be traced back to defect materials.  Supply management plays a key role in procuring quality materials by working with suppliers to define quality for the materials.

 

    • Pricing Flexibility – Supply management must focus on get the lowest total cost of ownership and not just the cheapest price.  Marketing benefits through supply management getting the lowest cost for goods by having the ability to charge varying prices based on a product’s price elasticity.

 

 

    • Innovation – Collaborative and alliance relationships with the firm’s supply base play a key role in ensuring and enhancing technology.  The development and management of supplier relationships is a key responsibility of a supply management.

 

    • Enhanced Customer Satisfaction – Strategic Supply Chain Management helps achieve shorter fulfillment lead times, consistent on-time delivery, high fill rates, complete orders, quicker responses to customer requirements, and the ability to meet unique or special requests.

 

 

    • The Supplier of Choice – By providing the best value, (a combination of quality, service and price), a firm becomes the supplier of choice to another channel member or to the end customer.

 

    • Customer Fulfillment Flexibility – Strategic Supply Chain Management provided the supply support which allows a firm to be responsive to customer desires for flexible lead time and changes in product configurations.

 

    • Shorter Cycle and Lead Times – These benefits result from improved supplier relationship and involvement in supplier product and process improvements.

 

 

  • Lower Total Cost of Ownership (TCO) – A firm has to take all costs into consideration when looking at total cost.  These not only include the cost of the product, but also include servicing cost and post-ownership costs which include disposal costs.  The following benefits occur when getting the lowest TCO:

 

    • Better Product Design – Seventy to Eighty percent of TCO is built into the product need or requirement.  Early supply management and supplier involvement is critical in the early stage to reduce TCO.
    • Acquisition Cost – The acquisition cost of a product or service is a major part of the TCO.  Procuring the right materials, standardization (when necessary), and good sourcing and pricing best practices will lower acquisition cost.

 

    • Processing Cost – Effective supply management practices help to reduce costs throughout the supply chain process.

 

    • Quality Cost – Firms can achieve the lowest TCO by selecting suppliers who produce quality materials and products.  This lowers inspection and rework costs downstream in the supply chain.

 

    • Downtime Cost – Downtime of equipment can contribute to increased TCO.  Buying quality equipment may cost more in acquisition cost, but may result in less overall TCO through minimized downtime.

 

    • Risk Cost – An effective enterprise risk management (ERM) program can improve a firm business continuity plan by lowering the risk of business disruption, which can lower inventory buffer stock and reduce TCO.  Managing supplier relationships are necessary in achieving lower TCO.

 

    • Cycle Time Cost – Effective process management lower TCO by helping to get products faster to market.

 

    • Conversion Cost – Eliminating waste and scrap through efficient process management and quality machinery help to lower costs and overall TCO.

 

    • Non-Value Added Costs – Firms need to take non-value added processes out of making a product or service. One can eliminate forty to sixty percent of costs and improve TCO.

 

    • Supply Chain Cost – The development and management of supply chains and supply networks require a significant investment, primarily in the form of human resources.  The proper selection, training, and education of individuals involved in supply chain processes can reduce TCO.  Improved technology, along with the know how to use it, will also reduce overall costs.

 

    • Post-Ownership Cost – Firms many times overlook disposal costs, but these costs can influence the selection of a product or service due to a higher TCO.

 

Supply Management and Return on Investment

 

We have discussed the Strategic Profit Model/DuPont in Week two and how good supply chain practices reduce supply chain costs, so we will not discuss them again